Equilibrium Transition from Loss-Leader Competition: How Advertising Restrictions Facilitate Price Coordination in Chilean Pharmaceutical Retail

TL;DR

This study shows that advertising restrictions in Chilean pharmacies shifted pricing from aggressive loss-leader strategies to coordinated, higher prices by reducing demand spillovers and elasticity, illustrating regulation's unintended effects on market competition.

Contribution

It provides empirical evidence that advertising bans can facilitate price coordination in oligopolies by weakening demand spillovers and elasticity, a novel insight into regulation's impact on market dynamics.

Findings

Advertising ban reduced demand spillovers and elasticity.

Prices shifted from aggressive loss-leader to coordinated levels.

Regulation unintentionally promoted price coordination.

Abstract

This paper examines how regulation can push an oligopoly from one pricing regime to another. It uses rich data from Chilean pharmacy chains to study a ban on comparative price advertising. Before the ban, ads created demand spillovers across products, making aggressive loss-leader pricing profitable. Once these spillovers were removed, selling below cost became unattractive for any firm, and prices quickly shifted to a coordinated, higher level. A structural demand model shows that the ban reduced both price elasticity and cross-product spillovers, and counterfactuals indicate that the loss of spillovers, rather than just lower elasticity, mainly explains the move to the new coordinated pricing regime. The results show how well intentioned regulation can unintentionally promote price coordination by weakening the mechanisms that support competitive outcomes.